Sloan Partners’ Director of Taxation, Michael Fromstein has been a senior tax and accounting expert since 1982. In addition to being Sloan Partners’ resident “tax man”, Michael conducts professional development courses for the Ontario School of Chartered Accountants. No tax matter is too big or small considering Michael’s clients range from those who are dealing with personal or family finances, to small business owners and large corporations.
Who are your typical clients?
I generally get two types of clients. The first is someone who is already making money and planning to expand a business. They want to know if there are different alternatives to doing so. One of the main questions I’m often asked actually is how to expand a business to the US. There are various incentives for carrying on a business in Canada and you often lose those if you want to move to the States. People are usually not sensitive to that. On the other hand I have those clients who are starting up a new business and they either want to know how to structure that enterprise, or they’re looking to attract investors. So I’d say that my clients are generally at both ends of the spectrum.
What kinds of tax issues should a new business owner be aware of at the start up?
Well, nobody wants to be the first person to give somebody money for their business, so usually when someone comes to me, they’ve already been running the business for some time. To add to that, they’re running that business on what we call “friends and family money”. That can be their own money, their brother’s money, or whoever’s money they may have borrowed. Take that into account and they’ve got some kernel of a small business going. Sometimes they’ve got a good business plan. Quite often, they might have great business potential but they don’t have any written plan, not even one on a napkin. They may have a good business, but not a good business plan.
They come to me because they need more money to help the business reach its full potential. Before they can start making money the question is “how do I get more money?”. Well the answer is that they have to get an investor. People often underestimate what information they need to provide an investor. There are different formats in which the investor can give money, some are cheaper from a tax perspective than others. In some cases, an entrepreneur may be able to pass along tax deductions to their investor which lower the investor’srisk and increase ROI. What I take a look at is what the potential tax impacts from some of the different elements funded by the investment – based on the business model and the entrepreneurs’ projections. I look at whether the business owners legitimately can pass tax deductions onto the investor. If you can do it legitimately, the investor might say “Well, I’m not really risking a dollar, I’m only risking 65 cents” and be more inclined to invest.
What does someone who is looking to expand their business have to do in order to attract more investors? What are investors looking for?
That will depend on the investor. Ultimately, the business owner needs to have a plan that convinces investors that they’re going to be very profitable if they get this extra money. As for what investors are looking for, that really depends on the investor. You’ve got all different types of people; those who might be attracted to the idea, those who might like the idea of being involved, and those who might like the people involved. No one’s investing if they don’t like the people involved. They might not like you personally, but they’ve got to at least respect you on a business level. After that they might say “okay, I want 30% return on my money if it works” or “I want some kind of investment that will give me a much better rate of return than buying a GIC at the bank”. Sometimes they may even understand the business they invested in and have a keen interest in it. In that case, they may even be able to add some value to the business because they have some networks or expertise but don’t want to spend a lot of money. That’s when the entrepreneur usually comes to me and I can give them some insight on how to structure the investment. Some ways to do it are less painful to the investor than others.
What would make a business more attractive in the eyes of an investor?
I usually recommend that they defer incorporating a new business. It gives you more flexibility for a number of reasons. For example, say this client is actually in the tech business. You can be successful and have someone wanting to buy you out within in a couple of years. There are tax rules on not paying taxes on some capital gains, but only if you own the shares for a 24 month limit. That rule doesn’t apply if you start as a partnership. In that case, there is no 24 month rule. You start the business, you incorporate, and you can sell it that afternoon and not pay any tax. That’s a pretty good deal, and gives investors a lot of flexibility. What you’re going to do with that flexibility depends on how you want to position your business. But basically, deferring incorporation reduces operating costs, reduces investor risk, and increases flexibility.
Are there any other strategies you would recommend?
Networking is important. Sometimes, all it takes on my end is introducing one client to another. For example, we have one client who just sold a business and we introduced him to an internet company for a new business he was launching. He’s basically changing his whole business model based on the introductions we gave him. So having a network can be as important as a tax strategy, but unfortunately that’s not guaranteed to happen with every business so it’s important that people do this on their own.
What kind of advice would you give to an established business owner looking to sell their business?
I would advise a client with a more mature business not to wait until they’re ready to sell to begin looking at tax implications. We would typically engage those clients before they’re ready to sell. So I guess the advice I can give is telling them what not to do. Let’s say you have a company whose owner wants to sell a manufacturing business. They own the business and they own the building where it is located, and although they’ve found someone to buy the business, they aren’t able to sell the building. Now they’re essentially stuck with a business that they can’t afford to sell. The first thing I do is have them separate the assets they own when they have a business that incorporates property, or even register the property to another business. Getting them to separate the property and business into different legal entities means they can sell it all to one person if they so choose, but it doesn’t always happen that way. So, the main advice is, separate the business you’re selling from the real estate and maximize the number of owners in the family group so that you have more access to tax savings.
What about passing on family property, like a cottage? How can someone do so with minimal tax implications?
In this case there unfortunately isn’t a solution that makes the process completely painless. But, a strategy that is often used is to create a family trust. Properly structured, that can sometimes slightly reduce some of the taxes payable. It will almost never reduce all of the taxes payable. Every family group (a family group constitutes a person, their partner, and children under 18) is entitled to one principle residence exemption where you don’t pay taxes when you sell your house. In a properly structured family trust any children who were in university and didn’t have their own house would then be entitled to a principle residence exemption on the increasing value of the house during that time, and that would be saving taxes until the kids went out and bought their own house. Under the proper circumstances, the same strategy can be applied to a cottage. A takeaway for anything we’ve discussed is that it’s always cheaper and easier to do things right the first time then to try to fix mistakes afterwards.
In your opinion, what is something everyone should be aware of when it comes to their taxes?
There’s a lot to know when it comes to taxes in Canada. Some of the recurring themes are family trusts, tax implications of owning real estate, and transactions with long-term consequences. If you go out for lunch, you eat your lunch, lunch is over. With tax transactions, the consequences stick around for 10, 20, even 30 years. It’s good to know the short term and the long term consequences of those things. If you make a tax mistake, the mistake doesn’t go away. My advice to anyone concerning their taxes or anything else is be informed.
If you’re interested learning more about tax strategies that will help grow your business, contact Michael Fromstein for a more personalized consultation.